Magic Software Enterprises(MGIC) - 2018 Q4 - Annual Report

PART I This part covers the company's financial performance, business operations, risk factors, and corporate structure Key Information This section provides selected financial data, outlines the dividend policy, and details various business, share-related, and geographic risk factors Selected Financial Data This section presents the company's selected consolidated financial data for the five years ended December 31, 2018, highlighting consistent revenue growth and fluctuating net income, along with details on the dividend policy Consolidated Statement of Income Data (2014-2018) | | 2014 | 2015 | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | :--- | :--- | | | (U.S. dollars in thousands, except per share data) | | | | | | Total revenues | 164,304 | 176,030 | 201,646 | 258,140 | 284,375 | | Gross profit | 64,577 | 62,809 | 68,264 | 82,979 | 88,818 | | Operating income | 20,726 | 21,434 | 21,087 | 25,956 | 31,698 | | Net income | 25,351 | 17,076 | 16,708 | 17,914 | 24,776 | | Net income attributable to Magic's Shareholders | 15,520 | 16,198 | 14,169 | 15,442 | 19,883 | | Diluted earnings per share | $0.36 | $0.36 | $0.27 | $0.35 | $0.39 | Consolidated Balance Sheet Data (2014-2018) | | 2014 | 2015 | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | :--- | :--- | | | (U.S. dollars in thousands) | | | | | | Working capital | 103,049 | 106,945 | 113,668 | 122,403 | 158,301 | | Cash, cash equivalents, short term deposits and marketable securities | 84,430 | 76,684 | 87,822 | 90,946 | 113,920 | | Total assets | 224,184 | 239,846 | 316,399 | 342,539 | 362,326 | | Total equity | 187,724 | 193,106 | 196,641 | 213,563 | 248,369 | - The company's dividend policy was amended on August 9, 2017, to distribute up to 75% of annual distributable profits, an increase from the previous 50%[39] - Dividends have been paid consistently since 2012[39] Risk Factors The company faces multiple risks in supply chain, regulations, and international trade - Business & Industry Risks: - Dependency on a limited number of core product families and services[43] - Rapid technological changes could render products obsolete[46] - Intense competition from larger companies with greater resources[57] - Potential for losses on fixed-price contracts if costs are underestimated[73] - Reliance on a small number of key customers, with the top five accounting for 27% of revenues in 2017 and 2018[73] - Risks associated with integrating numerous business acquisitions made over the past five years[73] - Risks Related to Ordinary Shares: - Dual listing on NASDAQ and TASE may result in price variations and low trading volume could cause volatility[110] - As a foreign private issuer, the company is exempt from certain SEC rules, providing less disclosure than a domestic U.S. company[113] - The controlling shareholder, Formula Systems (1985) Ltd., owns approximately 45.21% of outstanding shares, giving it significant influence over shareholder matters[115] - Potential adverse U.S. tax consequences if the company is classified as a Passive Foreign Investment Company (PFIC) or a Controlled Foreign Corporation (CFC)[117] - Risks Related to Location in Israel: - Political, economic, and military instability in Israel could disrupt operations[119] - Obligation of personnel to perform military service may disrupt operations[122] - Rights of shareholders are governed by Israeli law, which differs from U.S. law, including a shareholder's duty to act in good faith[126] - Provisions of Israeli law may delay or prevent an acquisition of the company[127] Information on the Company This section provides a comprehensive overview of the company's business segments, history of strategic acquisitions, proprietary software platforms, vertical solutions, organizational structure, and leased properties History and Development of the Company This section outlines the company's history, including its NASDAQ listing and strategic growth through numerous acquisitions and a significant private placement - The company was organized in Israel in 1983 and has been listed on NASDAQ since 1991[128] - Its shares also trade on the Tel Aviv Stock Exchange (TASE)[128] - Significant growth has been achieved through acquisitions, including: - 2014: Formula Telecom Solutions Ltd. (FTS), a BSS software vendor, for $5.8 million[130] - 2015: 70% of Comblack IT Ltd. (mainframe services) and 70% of Infinigy Solutions LLC (telecom technical solutions)[131] - 2016: 60% of Roshtov Software Industries Ltd. (medical record systems) for $20.6 million and 100% of Shavit Software (professional services) for $6.8 million[133] - 2017: 100% of Futurewave Systems, Inc. (IT consulting and outsourcing) for $3.0 million[134] - In July 2018, the company issued 4,268,293 ordinary shares in a private placement at $8.20 per share, raising a total of $34.6 million net of expenses[135] Business Overview This section describes the company's two business segments, key proprietary software platforms, and various vertical software solutions, along with revenue breakdowns by type and geography - The company operates in two reportable business segments: Software Solutions (proprietary and non-proprietary software, maintenance, support) and IT Professional Services[137] - Key proprietary software platforms include: - Magic xpa: A low-code application platform for developing and deploying business applications[143] - AppBuilder: An application platform for high-end, mainframe-grade business applications[143] - Magic xpi: A platform for application integration[143] - Magic xpc: A hybrid integration platform as a service (iPaaS)[143] - The company offers several vertical software solutions, including Clicks (medical records), Leap™ (telecom billing), Hermes Solution (air cargo management), and HR Pulse (human capital management)[143] Revenues by Type (2016-2018) | Revenue Type | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | | (in thousands) | | | | Software sales | $19,626 | $21,644 | $25,454 | | Maintenance and technical support | $25,885 | $30,386 | $30,951 | | Consulting services | $156,135 | $206,110 | $227,970 | | Total revenues | $201,646 | $258,140 | $284,375 | Revenues by Geographical Market (2016-2018) | Geography | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | | (in thousands) | | | | United States | $100,470 | $123,113 | $137,066 | | Israel | $58,079 | $91,917 | $103,850 | | Europe | $23,642 | $26,635 | $28,257 | | Japan | $11,226 | $9,253 | $9,797 | | Other | $8,229 | $7,222 | $5,405 | | Total revenues | $201,646 | $258,140 | $284,375 | Organizational Structure This section describes the company's global organizational structure, comprising numerous wholly-owned and majority-owned subsidiaries across various regions - As of December 31, 2018, the company has a complex organizational structure with numerous subsidiaries across the globe, including wholly-owned and majority-owned entities in the USA, UK, Israel, Japan, Europe, India, and South Africa[254] Property, Plants and Equipment This section details the company's leased properties, including its headquarters in Israel and various global office spaces for its subsidiaries - The company's headquarters is a leased 23,841 square foot facility in Or Yehuda, Israel, with an annual rent of $0.4 million under a lease expiring in June 2019[256] - Subsidiaries lease office space globally, including in the U.S., Europe, Asia, and South Africa, with an aggregate annual cost of $2.4 million in 2018[257] Operating and Financial Review and Prospects This section analyzes the company's financial performance, liquidity, and capital resources, detailing operating results, cash flows, debt, and critical accounting policies Operating Results This section analyzes the company's financial performance, detailing revenue growth, gross margin changes, and operating income trends across its business segments Segment Performance (2018 vs 2017) | Segment | 2017 Revenues | 2018 Revenues | Growth | 2017 Operating Income | 2018 Operating Income | | :--- | :--- | :--- | :--- | :--- | :--- | | | (in thousands) | (in thousands) | | (in thousands) | (in thousands) | | Software Services | $77,100 | $81,332 | 5% | $13,451 | $17,430 | | IT Professional Services | $181,040 | $203,043 | 13% | $16,482 | $19,058 | - 2018 vs. 2017 Performance: - Total revenues increased by 10% to $284.4 million[289] - Gross margin decreased slightly from 32% in 2017 to 31% in 2018, primarily due to a higher proportion of lower-margin IT professional services revenue[298] - Operating income increased 22% from $26.0 million to $31.7 million[304] - Net income attributable to shareholders increased from $15.4 million to $19.9 million[304] - 2017 vs. 2016 Performance: - Total revenues increased by 28% to $258.1 million[305] - Gross margin decreased from 34% in 2016 to 32% in 2017, also due to an increased mix of IT professional services[314] - Operating income increased 23% from $21.1 million to $26.0 million[320] - Net income attributable to shareholders increased from $14.2 million to $15.4 million[320] Liquidity and Capital Resources This section reviews the company's financial liquidity, capital resources, cash flow activities, and compliance with debt covenants - As of December 31, 2018, the company had $113.9 million in cash, cash equivalents, and marketable securities, with a net working capital of $158.3 million[324] Summary of Cash Flows (2016-2018) | Cash Flow Activity | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | | (in thousands) | | | | Net cash provided by operating activities | $27,955 | $25,508 | $24,050 | | Net cash used in investing activities | ($34,203) | ($7,316) | ($19,554) | | Net cash provided by (used in) financing activities | $20,411 | ($19,414) | $8,426 | - In November 2016, the company obtained a NIS 120 million loan, with principal payable in seven equal annual installments through November 2023[322] - The loan is subject to several financial covenants, with which the company was in full compliance as of year-end 2018[323] Tabular Disclosure of Contractual Obligations This section provides a tabular summary of the company's contractual obligations as of December 31, 2018, including lease, acquisition, and debt liabilities Contractual Obligations as of December 31, 2018 | Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | | :--- | :--- | :--- | :--- | :--- | | | (in thousands) | | | | | Operating lease obligations | $6,235 | $2,224 | $3,305 | $706 | | Liabilities due to acquisition activities | $1,004 | $910 | $94 | - | | Severance payments, net | $3,934 | - | - | - | | Short and Long term debt | $28,049 | $8,661 | $10,241 | $9,147 | | Total contractual obligations | $41,397 | $11,795 | $13,640 | $9,853 | Directors, Senior Management and Employees This section outlines the company's board and senior management, their compensation, and provides detailed employee statistics by location and activity Compensation This section details the aggregate compensation for directors and executive officers, including a summary for the five most highly compensated individuals in 2018 Aggregate Compensation for Directors and Executive Officers (2018) | Compensation Type | Amount | | :--- | :--- | | Salaries, fees, commissions and bonuses | $3,738,408 | | Pension, retirement and similar benefits | $123,714 | 2018 Summary Compensation Table for 5 Most Highly Compensated Officers | Name and Position | Salary | Bonus | Equity Based Compensation | All Other Compensation | Total | | :--- | :--- | :--- | :--- | :--- | :--- | | Arik Kilman, Chairman, Software Group | $399,344 | $577,012 | $64,387 | $0 | $1,040,743 | | Yakov Tsaroya, President, Coretech Consulting Group LLC | $225,000 | $337,000 | $0 | $9,000 | $571,000 | | Arik Faingold, President, Integration Solutions division | $321,139 | $196,529 | $0 | $0 | $517,668 | | Udi Ertel, President, Software Division | $222,142 | $58,078 | $0 | $43,705 | $323,925 | | Hanan Shahaf, CEO of Roshtov Software Industries Ltd | $284,433 | $17,364 | $0 | $0 | $301,797 | Employees This section presents employee data by geographic location and activity, showing a growing workforce across various regions and functions Employees by Geographic Location (2016-2018) | Region | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Israel | 843 | 921 | 999 | | North America | 597 | 861 | 933 | | Asia | 122 | 139 | 164 | | Europe | 127 | 115 | 116 | | South Africa | 10 | 16 | 14 | | Total | 1,699 | 2,052 | 2,226 | Employees by Activity (2016-2018) | Activity | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Technical support and consulting | 1,238 | 1,615 | 1,761 | | Research and development | 206 | 181 | 198 | | Marketing and sales | 133 | 117 | 140 | | Operations and administrations | 122 | 139 | 127 | | Total | 1,699 | 2,052 | 2,226 | Major Shareholders and Related Party Transactions This section identifies major shareholders, details the company's control structure, and cross-references related party transactions Major Shareholders (Beneficial Ownership >5%) as of March 31, 2019 | Shareholder | Percentage of Ownership | | :--- | :--- | | Formula Systems (1985) Ltd. | 45.16% | | Clal Insurance Enterprises Holdings Ltd | 7.43% | | Phoenix Holdings | 6.01% | | Yelin Lapidot | 5.86% | | Harel Insurance | 5.58% | - The company is controlled by Formula Systems (1985) Ltd., which in turn is controlled by Asseco Poland S.A. through its share ownership and a shareholders agreement with Guy Bernstein (Magic's CEO and a Formula shareholder)[482] Financial Information This section references the consolidated financial statements, discloses ongoing legal proceedings, and details the company's dividend policy and payment history - The company is involved in a lawsuit filed by an Israeli software company seeking damages of NIS 34,106,000 (approximately $9.4 million) related to warning letters sent to clients about potential copyright infringement[497][498] - The company is defending against the lawsuit but is unable to estimate the chances of success[498] - The Board of Directors amended the dividend policy in August 2018 to distribute up to 75% of annual distributable profit[500] - The company has a consistent history of paying semi-annual dividends[500] Additional Information This section provides supplementary corporate information, including Articles of Association provisions and detailed Israeli and U.S. federal income tax considerations for shareholders - Holders of Ordinary Shares have one vote per share[524] - The quorum for a shareholder meeting is at least two shareholders holding at least one-third of the voting rights[525] - Israeli Tax Considerations: - The general corporate tax rate in Israel was 23% in 2018[536] - The company may benefit from reduced tax rates under the Law for the Encouragement of Capital Investments, including a 12% rate for a "Preferred Technology Enterprise"[563] - Dividends paid to non-Israeli residents are generally subject to a 25% withholding tax, which may be reduced by an applicable tax treaty[579] - U.S. Federal Income Tax Considerations: - Dividends paid to U.S. Holders are generally treated as ordinary income[590] - Qualified dividends may be taxed at lower long-term capital gain rates[594] - The company believes it was not a Passive Foreign Investment Company (PFIC) for 2018, but this status is determined annually and could change[603] - U.S. Holders may be subject to a 3.8% net investment income tax on dividends and capital gains[605] Quantitative and Qualitative Disclosures About Market Risks This section details the company's exposure to market risks, including foreign currency fluctuations, interest rate changes, and equity price risk - The company's earnings are predominantly affected by fluctuations in the value of the U.S. dollar against the NIS, Euro, Japanese Yen, and British Pound[620] - A hypothetical 10% increase in the value of the NIS relative to the U.S. dollar in 2018 would have resulted in a $1.1 million decrease in operating income for that year[622] - As of December 31, 2018, the company held $8.8 million in trading securities, with a hypothetical 10% decrease in prices resulting in a potential loss of approximately $0.8 million[623] PART II This part addresses the company's internal controls, disclosure procedures, and corporate governance practices, including audit committee and foreign private issuer considerations Controls and Procedures This section confirms the effectiveness of the company's disclosure controls and internal control over financial reporting as of December 31, 2018 - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of December 31, 2018[628] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2018, based on the COSO framework (2013)[629] - This assessment excluded the recently acquired Futurewave Systems, Inc[630] Corporate Governance This section details corporate governance practices, including the audit committee financial expert, code of ethics, accountant fees, and adherence to Israeli home country practices as a foreign private issuer - The Board of Directors has determined that Mr. Ettlinger qualifies as an audit committee financial expert[633] Principal Accountant Fees (2017-2018) | Services Rendered | 2017 | 2018 | | :--- | :--- | :--- | | Audit | $357,000 | $361,500 | | Tax and other | $46,000 | $201,000 | | Total | $403,000 | $562,500 | - As a foreign private issuer, the company follows certain Israeli home country governance practices instead of NASDAQ rules, including those related to maintaining a majority of independent directors and shareholder approval for certain equity compensation plans[641][642] PART III This part presents the company's consolidated financial statements for the fiscal year ended December 31, 2018, prepared under U.S. GAAP Financial Statements This section presents the company's consolidated financial statements for the fiscal year ended December 31, 2018, prepared under U.S. GAAP and audited by an independent firm - The consolidated financial statements for the three years ended December 31, 2018, are included in this section, audited by Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global[646][653]